What is the Right Amount of Money to Raise at a Startup?

Recently I’ve been debating with a number of young startup companies that are raising money in the next few months, “what is the right amout of capital to raise at a startup?”

It’s a tricky question with no clear answer. There are trade offs. And it obviously depends on the kind of business you’re building. Let me assume for this discussion it’s a garden variety 2010 IT or Internet business (as opposed to something requiring capital equipment or a life sciences project). Any answer will be subjective and any real answer will just be explaining the tradeoffs to you.

On the upper end I’ve spoken openly on many occasions that I think that raising too much money too quickly can be destructive. It’s like adding rocket fuel to space ship before you’re sure that it’s pointing in the right direction for take off (or even if all of the people on board are qualified to take this into outer space). It places undue pressure early in the company’s history to “do big things” when sometimes what is warranted is more prudence. It also takes options off the table if you eventually find out that this isn’t a VC backable business. I’ve spoken about this in a post entitled, “Do you even need VC?” to which the answer for most people is “no.” If you’re interested in that topic the link also has a short video I did on the topic for Fox Business News.

But the lower end also has risks. I’ve seen too many entrepreneurs try to do things on the cheap. I know the standard line, “I want to do a small round now and raise a larger round later when we get A,B,C deal done and I can raise at a higher valuation.” If it works you’re a hero. But there are also problems / risks:

– the funding environment might change dramatically – there may never be a next round (see: March 2000, September 11, 2001 and September 2008)

– you may hit unexpected bumps in the road yourself making the next round tough

– there may be major competitive changes in the market that makes your next funding round hard (e.g. Google suddenly makes your product category free)

– you might do a great job in a great market but a competitor raises $3 million when you raised $500,000 and suddenly you have to compete with them

I’ve even heard people repeat this bullsh*t Silicon Valley mantra about “failing fast” which is horse puckey. The line goes like this, “well at least you know early that your business isn’t going to work and you didn’t have to waste 2 years and $1 million trying to bang your head against a wall.” That is so self centered it winds me up. Tell that to the person who wrote you the $50,000 of their hard earned money and entrusted you to try your best. Fail fast? How does your brother-in-law feel about that?

And how do you think the next person who’s thinking about writing you a check going to feel about that sort of cavalier attitude with their money? Fail fast = quit and give up easy = spaghetti against the wall = no clear strategy going into your business = no ability / willingness to try and pivot as market conditions change = easy way out = today’s management mantra that will be laughed at in 10 years. Who started this meme? I say define a strategy, test it up front and pivot if you’re not getting the traction you had expected. Fail fast on your own dime.

Whoops. Off topic. But seriously, if you take somebody’s hard earned money treat it and them with the respect they deserve.

So, let’s say you’ve raised $200,000 in friends and family money and you’re thinking about raising a round of $1 million and investors offer you $2 million. Should you take it? Let’s assume that the $2 million buys 25% of your company, which is the norm in an equity financing.

– obviously the starting point is to ask yourself how much money you’ll need until the next milestone. It’s best if you can raise at minimum 12 months’ cash and even better 18 months’ cash. 24 months for most tech startups is usually too much money.

– add a buffer. Your revenue will take longer to ramp then you think. There will be some unforeseen expenditures.

– that is the correct amount to raise. It should pop out of your business plan

– and don’t ask for an extra $3 million to do M&A. No good investor wants that. They can fund a deal if necessary and valid at the time you present an acquisition target to them

So let’s assume that in the above scenario $1 million gets you 15 months and $2 million gets you 2 years. What to do?

This is actually something I’ve debated a lot recently. I was at breakfast with my friend Dave Young (from DLA Piper) this morning and we debated the topic. He had the best response I’ve ever heard. He said,

“When someone’s passing the hors d’oeuvres tray you always take two”

Brilliant. I think that if you’re offered fair terms that aren’t destructively dilutive, preserve options for an exit, don’t put undue pressure on your company to do things too quickly you TAKE THE MONEY. I know you think you’re going to do a bigger round later at a higher price but the problem is that if someone offers you $2 million now it’s guaranteed. That same extra $1 million might prove very difficult to get one year from now if something fundamentally changes in the market, your company isn’t getting traction as quickly as expected or your competition makes a lot of noise in the market. Or even your investors start having their own liquidity problems!

So I came up with the corollary,

“When someone’s passing you the hors d’oeuvres tray always take two. But don’t take the whole tray.”

The whole tray is obviously unhealthy. Look, these things are judgment calls and there are no mathematical answers. Just remember that for many companies success or failure often ends up being a binary outcome. Businesses usually fail for the exact same reason – they run out of money. Don’t let that be you. If the appetizers are in front of you, take two.

You raise a good point. I do not assume lightly that anybody can raise $200k. It's just that for the point of this article I was talking about a company that was at the stage of considering $1 – $5 million. These companies would have likely already raised an earlier round. I'll make sure to talk about the early, early stages another day. Thanks for bringing it up.

http://bothsidesofthetable.com msuster

Thanks, Daniel. Good luck getting the biz off the ground.

http://bothsidesofthetable.com msuster

I agree whole heartedly. I hope I made that point. Too much money too early is destructive to all involved. I think it's in the post I linked to.

http://bothsidesofthetable.com msuster

No, that's an unfair retort. The opposite of not agreeing that “fail fast” is a sensible strategy IS NOT to say that you must work years to get product to market. I'm going to write about this tomorrow. Feel free to attack my arguments then! I welcome the debate.

http://bothsidesofthetable.com msuster

Agreed. I wan't “fail fast” to be rebranded to something else. “Validate Early” or something similar works for me.

http://bothsidesofthetable.com msuster

If you have no other options and you're out of cash – maybe. But I really advise against it if you can avoid it. If you really want to talk about a specific situation email me at msuster at gmail dot you know what and I'll do my best to get back to you.

http://bothsidesofthetable.com msuster

Congrats. Awesome outcome.

http://bothsidesofthetable.com msuster

I agree with sentiment including not worrying about competitors. But there are companies that “try to do things on the cheap” and end up getting beat by better financed competitors. It's a balancing act.

http://bothsidesofthetable.com msuster

As in you know your business is going to fail? Not sure what you mean?

http://bothsidesofthetable.com msuster

I love that quote: the Chinese saying: “The temptation to quit will be greatest just before you are about to succeed.” Thank you.

http://bothsidesofthetable.com msuster

Awesome. Thank you. Fixed. Always appreciate when people spot typos.

philsugar

I just read your post Do you even need VC…it should be a mandatory read for every company that goes to an event where the premise is how to raise money.

I think you're saying figure out the absolute minimum you need and optimally double it….I can agree with that, but taking no more.

I also use the rocket fuel analogy…I always say once you take the money you are going to burn it and if you don't get off the pad its ugly.

I don't worry if a competitor raises a ton more because you can “steal their heat”. Its like living in an apartment where all your neighbors keep their apartments super warm and you keep yours cold. You use almost no energy, but feed off of theirs. In the company example you can use all the money they spend to develop a market and use that to your advantage.

I agree with the “fail fast” bullshit. This will go down like “internet time”.

One thing I think people forget is that markets don't always move “away” from you. Away meaning if you don't get tons customers and great adoption now, someone else will. In a space that is taking off, yes this is true.

However, sometimes it takes time for a market to start moving, sometimes it doesn't move very fast, sometimes it takes time to gell (i.e. you go through enough iterations to figure out what's right). In this case if you've taken the “fail fast” mode or raise too much rocket fuel…you'll burn up before the market starts moving “towards” you.

http://bothsidesofthetable.com msuster

I love your point about paying customers. I'm gonna use that in tomorrow's article. Thank you.

http://bothsidesofthetable.com msuster

Mostly agree. Just be careful about doing huge VC rounds too early (e.g. $10 million when you're pre revenue)

http://bothsidesofthetable.com msuster

msuster at gmail dot you know what. I try my best to get back to people. Sometimes fall short. Be persistent.

http://twitter.com/stnik Nik Souris

@msuster great perspective… You might also consider not taking any hors d’oeuvres when the party is ending without a next stop

http://reecepacheco.com reecepacheco

Happy to have inspired you.

http://twitter.com/stnik Nik Souris

you know me failure not an option. I was playing on your analogy of the Hors D'oeurves being “capital” and calling out that an entrepreneur needs to know when that soiree (personal money, family funding, etc) is finished your next stop has interested “investors” and/or you can sustain yourself. Basically, knowing the capital markets that will support your business and its market.

philsugar

Agreed, but I'm taking your premise of determine what you realistically need…..that should be a truly conservative estimate of what it would take for you to be able to be profitable not that you have to hit break-even if you are taking it out of the park, just that you have the ability to control your own destiny and get profitable and be happy if you can take double that amount….

This as opposed to take as much as you can.

So given you figured out what you realistically needed, if you have a competitor that took as much as they could, don't change your funding based only on that data point. You can steal heat.

And I've personally watched situations where there are several competitors in a market, one gets a ton of financing, another also takes a ton out of fear, and the only one left standing is the one that matched the financing to the opportunity.

I can give concrete examples but I don't have to because…..ironically you need to look no further than the VC industry.

You are totally right if you end up being cheap and constraining growth while somebody else really puts down the pedal you will get beat.

Hal

This was a great post.

As a startup guy, I'm thrilled to read such common sense and honesty without one hint of the the usual self-service so many post VC/Angel blogs seem to have lately.

philsugar

Customers are a great point….and I would add employees.

When you as an entrepreneurial company screw people by “failing fast” you have pissed in the communal entrepreneurial well!

It makes it harder to ever sell that person (whether she is a potential customer or potential employee) to work with an entrepreneurial company ever again.

Will P

Speaking of raising $10M pre-revenue, what is your take on Square? They raised a giant Series A, helped by the celebrity status of the founder, for an iPhone app with a hardware dongle and a transaction processing backend.

http://www.piqqle.com/blog/ Daniel Kim

Grooves,

really enjoyed reading your comments. As a first time entrepreneur, I do hear a lot about raising first capital from F&F. I come from a background that my trusted contacts do not have the type of money I am looking to raise as a seed round ($200-250K). Because my company is web related, I am fortunate enough to use open source languages to create a a great technology and web site. With my recruiting ability, I have partnered with young developers that believes in the idea of the company and is working well (albeit part time) on mainly sweat equity.

I use as much funds as I can to provide for everything else until we can get to a point where the site in private alpha and it can start rolling out to users and customers. It is at this point, where I think for us, additional capital will be needed and hopefully a slick working system, that is still pre revenue and has some traction/customer feedback will be enough to raise funds to create some sort of runway.

But I would definitely be interested in seeing this “some analysis or an article about entrepreneurship and social mobility”.

BTW- Mark, great article as always!!

http://www.elieseidman.com Elie Seidman

Smart of you to call bullsh*t on the fail fast meme. Great post – it reminds me of two excellent things I've read. Steve Blank has said something to the effect of a startup is a search for a business model. http://steveblank.com/2010/03/11/teaching-entre…. Without enough time (money), it's going to be hard to iterate through the things that don't work. Parsons has his great rules for success and there are two that I have fond to be constantly true and relate to your post in general

“1) the Chinese saying: “The temptation to quit will be greatest just before you are about to succeed.”2) Never give up. Almost nothing works the first time it's attempted. Just because what you're doing does not seem to be working, doesn't mean it won't work. It just means that it might not work the way you're doing it. If it was easy, everyone would be doing it, and you wouldn't have an opportunity.”

If you think you need money for 15 months, you almost certain need money for 30. There are a few lucky folks who figure out whether it will work in a year or even two but those are the rare exception. Far more common are th 5 and 7 year “overnight successes”. Entrepreneurship is a bad place to be if you are not persistent and resilient. For almost every startup, there will be a cycle where at first everything will look great, and then it will look bleak. I truly believe that it's what you do when you stare into that bleak abyss that decides the likelihood of your success as an entrepreneur.

http://reecepacheco.com reecepacheco

Sentence 1: “what is the right *about* of capital to raise at a startup?”

#keepingyouhonest

http://reecepacheco.com reecepacheco

That 'cavalier attitude' is ridiculous. If people put money in your business, you better not let them down. I don't care how much (or how little) they put in or how loaded they may be – the point is to generate a return. They believed in you, so stay true to your word.

I spoke to an entrepreneur a while ago who had raised ~$300k, had a product but the thing wasn't going anywhere and he didn't seem to give a shit one way or another. Despicable.

Know who else you shouldn't fail fast with? Paying customers. My business has a bunch of them, and a lot more users who really depend on our service. They're relying on us. Failing fast may be an out for our bootstrapped lives, but it's not an option.

Build a business or die tryin.'

http://twitter.com/brianmba Brian Ostrovsky

I actually liked the term “fail fast” but I understood it differently, for me it was more about iterating and not falling so in love with or spend so much developing your idea/product/approach that you can't adjust. But with the definition you gave, I can definitely see what investors want entrepreneurs to have real skin in game .

It's just the sort of emotional (if not monetary) investment I want those who join my team to have in what we're doing. Even if you don't ever 'fail' there's definitely going to be roadblocks and I don't want people thinking about abandoning ship when things get tough.

http://bothsidesofthetable.com msuster

I think I'll avoid answering that one …

http://pfm.myopenid.com/ pfm

“The time to take the tarts is when they're being passed.”Eugene Kleiner – from wikipedia

first you need to be at the right party… some tarts taste better than others

Gorilla

Never turn down money. Never. Companies don't go out of business for having too much money.

Now if you are an idiot and a poor operator and you go out and hire fancy consultants and buy even fancier chairs and you burn through that money, then you were likely to fail with any amount that you raised.

I reiterate – if an angel or VC is offering you money, especially in this down economy, take all of it.

philsugar

Spot on..especially “5 to 7 year overnight successes” Everybody loves the glamour of the very, very few fortunate “overnight successes” versus the majority of successes that spent years doing everything including taking out the trash……they even turn those stories into overnight successes.

http://twitter.com/Lasse_Koivisto Lasse Koivisto

Hi, Mark.

I have a question that is not related to this subject…Is there any way that i can contact you?

Thanks

P.S By the way, great post.

daytulu

People use the term 'fail fast' for different things. As giffc is saying it might mean 'validate early' or as Erik and Keith mentioned it might be just about iterating the product. But as Mark is saying, at least in this post, it means to pack up and go home when there is no immediate traction for the idea. You simple cannot say “Don't worry, with your money we will fail fast” to any investor, in any other place around the country. The reason this term appeared I think goes back to the fact that too much money went into the VC. If what Paul Kedrosky is saying true, which I wholeheartedly believe is, we will not be hearing this term soon, even in Silicon Valley. Here is the Kauffman Foundation paper: http://bit.ly/d5xWxz. I fully understand why this term emerged. If you are a VC in Silicon Valley, you have almost unlimited access to ideas/teams/startups. And if you have too much money in your fund, then the concept of failing fast becomes a frequently used term. VCs simply would like to move to the next deal and don't waste time (they might think it is easier to pump money into a new idea rather than trying to make an existing one work). And entrepreneurs know this and adjusting their pitch accordingly, that's all. Both sides contribute this trend. The same entrepreneur, if he/she is a rational person, would not use this term in another city.

philsugar

I think the F&F is kind of like the warm introduction to a VC. It really doesn't have anything to do with social status it has more to do with how much/hard you are willing to hustle.

There are things that are going to be a whole lot harder and require more of the same exact skill it takes to find people/get a warm introduction to become successful.

http://bothsidesofthetable.com msuster

I prefer 18 months. 12 is too short. I just put it out there because sometimes startups struggle to raise enough for 18 months. 12 is better than 0. That's all.

http://bothsidesofthetable.com msuster

Small funds, less capital = good. Fail fast = bad.

http://bothsidesofthetable.com msuster

tad too little is fine. tad too much is fine. It's when it's more than a tad in either direction that it causes problems. All this has to start from a realistic financial model and what you really need.

http://bothsidesofthetable.com msuster

I know. I'm going to write about this tomorrow. The branding of fail fast is all wrong. People didn't read the entire memo, just the tagline. And they walked away with the wrong message.

http://bothsidesofthetable.com msuster

You raise a good point. I do not assume lightly that anybody can raise $200k. It's just that for the point of this article I was talking about a company that was at the stage of considering $1 – $5 million. These companies would have likely already raised an earlier round. I'll make sure to talk about the early, early stages another day. Thanks for bringing it up.

http://bothsidesofthetable.com msuster

Thanks, Daniel. Good luck getting the biz off the ground.

http://bothsidesofthetable.com msuster

I agree whole heartedly. I hope I made that point. Too much money too early is destructive to all involved. I think it's in the post I linked to.

http://bothsidesofthetable.com msuster

No, that's an unfair retort. The opposite of not agreeing that “fail fast” is a sensible strategy IS NOT to say that you must work years to get product to market. I'm going to write about this tomorrow. Feel free to attack my arguments then! I welcome the debate.

http://bothsidesofthetable.com msuster

Agreed. I wan't “fail fast” to be rebranded to something else. “Validate Early” or something similar works for me.

http://bothsidesofthetable.com msuster

If you have no other options and you're out of cash – maybe. But I really advise against it if you can avoid it. If you really want to talk about a specific situation email me at msuster at gmail dot you know what and I'll do my best to get back to you.

http://bothsidesofthetable.com msuster

Congrats. Awesome outcome.

http://bothsidesofthetable.com msuster

I agree with sentiment including not worrying about competitors. But there are companies that “try to do things on the cheap” and end up getting beat by better financed competitors. It's a balancing act.

http://bothsidesofthetable.com msuster

As in you know your business is going to fail? Not sure what you mean?

http://bothsidesofthetable.com msuster

I love that quote: the Chinese saying: “The temptation to quit will be greatest just before you are about to succeed.” Thank you.

http://bothsidesofthetable.com msuster

Awesome. Thank you. Fixed. Always appreciate when people spot typos.

http://bothsidesofthetable.com msuster

I love your point about paying customers. I'm gonna use that in tomorrow's article. Thank you.